Monday, March 19, 2012

Bill Mitchell has a post with a re-exposition of the JG, and this is a repost of some comments I made there trying to clarify the mechanism that ensures workers automatically leave the JG job in an expanding economy. What is the mechanism that ensures workers leave the JG job in an expanding economy? Will the government force people to leave the JG?

As I understand it, MMT proposes the JG program to permanently guarantee a job at a set wage to anyone looking for a job. While I understand the need for a jobs program now, when the rest of the economy is contracting/ hoarding/ deleveraging/ correcting, my concern is for when the JG gets the economy starting, and companies start hiring again.

The JG is proposed to offer the living wage, and I agree, both on the principle of fair pay for a fair day’s work, and that for it to work in increasing aggregate demand, it should be at this level. JG therefore eliminates bad jobs with crappy wages due to competition from the JG, which to me is an appropriate goal.

MMTers claim that this is a “one-off” price level boost. So let’s take this ”one-off” price level boost as a given, and think one step ahead. Since the government will continue to put a demand floor to wages under a JG, any heating up in the private sector results in demand shooting above 100% for labour. During a strong expansion, when more businesses are expanding and therefore hiring, the excess demand the JG maintains for workers makes labour scarcer than necessary, and therefore businesses will need to bid up higher to attract people. The only way new firms attract workers is to drive them ever higher above not only what the JG pays, but above what the first few firms to hire are already paying. The more people a firm needs, the higher the labour clearing price for the firm. The higher the clearing price, either less firms start, or higher inflation ensues.

Keeping the JG in such an expansionary environment risks the JG becoming a negotiating ploy for smart workers who know how to use the system, to extract higher wages than they can otherwise. And remember that we’re already talking about a JG program that pays the living wage, so the STARTING POINT for the private sector is to offer higher than this living wage. This means there’s less room for the private sector expansion before it turns into an inflationary environment that would then need to be curtailed by government.

We then get to the mechanism that MMT claims makes the JG program also a price stability program. Paired with tax and interest rate policy, inflation in this scenario can be slain without increasing unemployment, by increasing rates and taxes, so companies scale back operations and lay people off, or businesses close, and more people go back to the lower paying JG job. For a permanent JG to work, the private sector has to stay only up to a certain size, beyond this, the government starts squashing them to ensure price stability.

Hence, if you’re thinking of starting your business once the economy passes this level, you’re going to have to think again, because government will be expected to tighten soon (not by dropping the JG, but by making it more expensive to maintain a small business). Because the government keeps this floor on labour demand even during the boom times, when the economy gets booming, the boom acceleration will be much faster than if the government had withdrawn its additional demand instead. So again, if you’re a businessman, you’ll likely obsess about where this “certain level’ is at.

This is what I meant when I say a permanently fixed JG economy replaces a buffer stock of unemployed with a buffer stock of failed small businesses. Large companies may weather this price stabilization drive by shedding workers, but smaller businesses will close completely. Since a permanently-fixed JG involves a buffer stock of failed small businesses, banking losses will always follow an increase in this buffer stock due to fighting inflation, and there will be great capital wastage due to the closing up of businesses, selling off of inventories, etc. following this increase. In short, I’m getting that under a JG, both bankers and private entrepreneurs will be reluctant to start or fund new small businesses. Whatever jobs get created going forward will have to come from big business, or the JG itself.

I’m not against the JG as a countercyclical policy, but using it as a price stability mechanism means that 1) it seeks to keep private sector only up to a certain level, and 2) with onset of inflation, its price stability mandate kills a lot of new private sector growth just when it’s gaining momentum, more than if the JG was downscaled instead.

The comparisons of permanent JG and no permanent JG in my mind remain: In a JG-less economy in recession, labour demand can be at 80%, while in a booming economy, it will be at 100%. In a permanently-fixed JG economy, labour demand during recession will be at 100%, while during a boom, it will be at 130%. Inflation-fighting taxation will be a lot harsher in the JG economy with 130% labour demand than in an economy with only 100% labour demand. Government will have to kill more private sector companies when it is trying to get that 30% excess demand back to 100% than when it’s trying to get 100% down to 96%. It seems the need to kill more businesses will be much lower if the JG was instead preemptively scaled down by government when the economy starts growing.

I believe that the JG, contra to many MMTers, will not automatically disappear, without distorting the economy, simply by virtue of JG workers leaving for the private sector. That kind of magical thinking is no different than monetarists believing that increasing money supply automatically increases its velocity. No, the JG ends only with the private sector bidding up wages so as to attract workers away from the JG. If this happens by more than a sufficient level, there would be higher inflation than is acceptable. The JG program, which will also have a price stability mechanism, will not stand idly by. The government under a JG policy will try to get prices back to the government’s stated level by getting people back into the lower wage JG, and away from the private sector. It will do so by all means that make it less profitable for business to thrive – taxation, interest rate policy, whatever, anytime the private sector expands by more than a certain level.

As far as I know, there has been no testing of JG on a significant scale, and perhaps only in certain areas where there really is no interest from private sector to invest. In which case, we really need a JG of some sort in that area. In a previous discussion I had with Tom Hickey, he mentions of places like Iowa, where small business have been permanently wiped out by large businesses. I agree with Tom that in these places a permanent JG could be helpful. These are places where the private sector would normally not invest in because it wouldn't be profitable. But there are other places where a permanent JG could eventually become counter-productive. It cannot be enacted on a similar scale, and permanently, in urban centers where private sector already tends to congregate. It will only end up squashing the grassroots initiative there, and the JG will eventually become an alternative economy unto itself, not a bridge for when private sector is weak. That's why when you propose the JG, it's important to make nuances, and signify how it rolls out by sector and geographic location. It's can't be a one size fits all for the entire country.

Advocating that government stand ready to hire “all ready and willing to work” without regard to the state of the economy is advocating for the monopoly currency issuer to tilt the playing field and compete with the currency-constrained private sector for - if there is an open job offer to everyone - scarce labour resource. In the same way iron is good for an anemic but bad for someone with hemochromatosis, a permanently fixed JG would be good or bad depending on the state of the economy. I’m merely suggesting this program needs to be localized rather than enforced in aggregate, and be flexible depending on what is going on in the economy.

Tom Hickey asks what macro policy solution I would suggest instead and what buffer and price anchor. The stock I could think of using as buffer, as is evident from my position, is the JG itself. A working JG proposal should be flexible either on the 100% employment guarantee, on the JG wage, or on the duration of the program, depending on the overall economy. In times of higher inflation, the JG is what adjusts, either in price (wage) or quantity of its workers. With JG flexibility, during a private sector expansion over-all wages don’t rise as fast, and hence, the boom can probably stay for longer, and the fiscal tightening needed to contain it not as harsh. I don’t have suggestions on price anchor, why change what we use now? Call me neoliberal if that’s what this makes me, but the permanently fixed JG has a tradeoff, as Tom acknowledges, and the tradeoff can just be as damaging economically as a buffer stock of unemployed. Less people may venture into private business creation and may end up relying more on government for many things. If there’s a JG during a recession, then everyone who can hold a job should be able to get a job. But when the private sector is expanding, then the JG should be wound down as a matter of policy, not merely as a passive result of people leaving for higher private sector wages.

6 comments:

Thanks, Tom, and thanks for engaging with an open mind. I'm after all not here to discredit the JG, just want to point out a point where JG as currently proposed is silent, or at most, muted.

In the end, as you said, it comes down to your choice between tradeoffs. Either you sacrifice the last unemployable person, or you sacrifice the next marginally profitable business. I choose to focus on the vantage where scaling down the JG does not sacrifice the unemployed, but gives a chance for the next marginal business to thrive, so it takes the place of the JG in employing same person.

The other vantage, which prefers to keep the JG permanent, because they believe the private sector expansion is not hiring that last person, I see as condemning that person to stay in the JG forever, because that last business that might have hired him did not get started, because of the added risks and complexities that the JG with a price stability puts on running a business.

You say “The JG is proposed to offer the living wage…”. The phrase “living wage” is very emotionally appealing: who can possibly be in favour of a wage on with it is IMPOSSIBLE to live? Same goes for another phrase you use: “fair pay for a fair day’s work”.

Both phrases are true by definition, and are thus not much use. I suggest sticking to the phrase “legal minimum wage” or “min wage plus X%” or similar.

You then say in respect of JG that “for it to work in increasing aggregate demand, it should be at this level”. That’s the “living wage” level. I suggest there is a flaw in that argument is as follows.

Increasing AD is easy. There is no need to resort to JG to increase AD.

Secondly, if AD can actually be increased (without inflationary consequences) why not just increase AD? That will result in an increased production of stuff that consumers are actually prepared to pay for, rather than the somewhat strange variety of stuff produced by your average JG scheme. I.e. a straight rise in AD will produce extra and more productive jobs than JG (whether the new jobs are in the PRIVATE OR PUBLIC SECTORS).

In short, AD should ideally be at the maximum level that is consistent with acceptable inflation (which I call NAIRU – but there are other phrases.)

Thus the real niche for JG comes in reducing unemployment when unemployment is at NAIRU, as I pointed out in this paper:

http://mpra.ub.uni-muenchen.de/19094/

Finally, I’m glad to see a JG advocate showing some concern about the inflationary consequences of JG. Too many JG advocates think this problem can be brushed under the carpet.

This problem was best summed up by the Swedish economist Calmfors in what he called his “iron law of active labour market policy”. This “law” is approximately thus.

If people are ATTRACTED to JG type schemes because of generous pay, that will inevitably REDUCE the relative attractions for them of normal or regular work. Therefor if a JG type scheme is to be a NET CREATOR of jobs, pay has to kept down, plus there has to be an element of “workfare” or coercion: i.e. “do this JG jobs else your benefits get cut”.

The alternative is to make JG pay relatively GENEROUS. But in that case, labour supply to the regular economy is reduced, which is inflationary, which means AD must be pared back, which in turn means JG jobs will to some extent be at the expense of regular jobs.

Ralph, Clonal made a comment about Roosevelt's WPA. That might be a compromise. How I see JG is as a full-time job at the start, when the private sector demand is weak. This gets scaled down, perhaps in a mechanism similar to the WPA example, when government sees that private sector hiring is already leading to average newly-hired private sector wages rising at say, 20% above the JG. The declining income from the JG should encourage the last JG holdouts to transfer to the private sector, and alleviate the wage bidding there.

Thanks, Greg. and yes, many small business currently fail within the first year of business. That's without a JG in place that can make wage bidding during an expansion more fast and furious, and tightening therefore more severe. I imagine it would be worse with a permanent JG with a price stability mandate.

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"Conventional approaches, unconventional conclusions" on the global finance and economic issues of the day. Rogue Econ has been a banker and financial consultant in several countries. Welcome to my blog.